Today we’ll look at Cheetah Mobile Inc. (NYSE:CMCM) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Cheetah Mobile:
0.02 = CN¥137m ÷ (CN¥8.5b – CN¥1.7b) (Based on the trailing twelve months to June 2019.)
So, Cheetah Mobile has an ROCE of 2.0%.
Is Cheetah Mobile’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Cheetah Mobile’s ROCE is meaningfully below the Software industry average of 9.9%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Cheetah Mobile’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Cheetah Mobile’s current ROCE of 2.0% is lower than 3 years ago, when the company reported a 3.8% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Cheetah Mobile’s ROCE compares to its industry.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Cheetah Mobile.
What Are Current Liabilities, And How Do They Affect Cheetah Mobile’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cheetah Mobile has total liabilities of CN¥1.7b and total assets of CN¥8.5b. As a result, its current liabilities are equal to approximately 20% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Cheetah Mobile’s ROCE
While that is good to see, Cheetah Mobile has a low ROCE and does not look attractive in this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Cheetah Mobile better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.